CLP

HONG KONG — The two electric power companies here agreed Monday to a new regulatory system that sets their annual rate of return, based in part on how much pollution they emit, a carrot-and-stick approach that could some day be a model for mainland China’s giant power industries.

The 10-year agreement between the Hong Kong government and the territory’s two companies — Hong Kong Electric and CLP — authorizes the companies to charge electricity rates that will give them a 9.99 percent return on assets.

If either company exceeds regulatory limits for any pollutant, however, it would be required to charge customers less, reducing its allowed rate of return by 0.2 to 0.4 percentage point.

If the companies manage to cut their pollution more than required, then they are allowed to raise prices to the point where they effectively earn bonuses of 0.05 to 0.1 percentage point on their rate of return.

A complicated formula also allows them to charge slightly more for electricity as they exploit renewable energy sources.

Western regulators increasingly provide complex environmental incentives and impose penalties on power companies. But regulators in mainland China and Hong Kong have tended to rely mainly on fines if companies fail to meet basic requirements.

Particularly on the mainland, though, fines are seldom assessed, and violations are rampant, according to environmental critics.

Mainland power companies also have limited incentives and flexibility to choose fuels that are more environmentally friendly than coal. For instance, only a few provinces allow wind-turbine operators to charge significantly more than coal-fired plant operators for the electricity they sell to the grid. And the rate subsidy for burning agricultural waste to generate electricity is not high enough to make it economical in many areas.

Instead, the regulatory system on the mainland has focused on keeping electricity rates as low as possible, with little regard for the pressure this puts on power companies to choose cheap but highly polluting coal-fired power plants.

Melissa Brown, a specialist in Hong Kong power regulation, who is executive director of the Association for Sustainable and Responsible Investment in Asia, a research group, said the new system in Hong Kong sets a useful precedent for the mainland.

“Anything that is a bonus-and-penalty scheme is a positive,” she said.

But Ms. Brown cautioned that regulators there were unlikely to follow the example soon.

She also noted that the government released too few details on Monday on future allowable levels of specific pollutants to make it possible to calculate the actual effect of the new agreement on air pollution here.

Smog has become a chronic problem in the city. CLP and Hong Kong Electric have denied that they are the main sources of pollutants, hinting that nearby factories and power plants on the mainland are to blame.

Exxon Mobil owns 60 percent of a power-generating joint venture with CLP, and CLP owns the rest plus all of the distribution grid, which serves three-quarters of Hong Kong’s nearly seven million people.

Two officials at the State Electricity Regulatory Commission in Beijing said on Tuesday morning that while the mainland and Hong Kong maintain separate regulatory regimes, the mainland is looking at ways to make power companies more responsive to environmental concerns by encouraging the use of alternatives to coal, notably by allowing generating companies to charge distribution companies extra for electricity from renewable sources.

Edward Yau, Hong Kong’s secretary for the environment, said that the government had set the new regulated rate of return at 9.99 percent after deciding that public opinion strongly favored a rate below 10 percent.

The previous rate, under a 15-year agreement expiring at the end of 2008, was 13.5 percent to 15 percent, and was widely criticized as excessively generous to the politically influential power companies. The new rate of return is still well above the prime rate of 6.75 percent that the dominant local bank, HSBC, charges for loans to companies with strong credit ratings.

Power companies may earn up to a combined HK$476 million a year less under new schemes of control that tie the emission of pollutants to returns, the Environment Bureau has said.

The companies which exceeded the emission cap of any single pollutant by between 10 and 30 per cent would have their rate of return cut by 0.2 per cent, the bureau said yesterday.

If emissions go beyond the caps by more than 30 per cent, the rates of return will be cut by 0.4 per cent. Based on 2006 assets figures, this means CLP Power (SEHK: 0002) may earn HK$290 million less and Hongkong Electric (SEHK: 0006) HK$186 million less.

Conversely, if the power companies achieve emission reductions of between 10 and 30 per cent below the caps, they will receive extra returns equalling 0.05 per cent.

If emission cuts go below the caps by more than 30 per cent, the companies will get extra returns of 0.1 per cent. That would amount to HK$73 million and HK$47 million for CLP Power and Hongkong Electric respectively. Hahn Chu Hon-keung of Friends of the Earth said it was difficult to assess if the penalty would be a sufficient deterrent.

He said little was known about 2010 or post-2010 emission caps and the limits already given were too lenient. Hong Kong has an agreement with Guangdong to cut emissions by 2010.

“The caps are quite lenient and there seems to be little difficulty for the power companies to meet them,” Mr Chu said. “It is almost guaranteed that they will get extra returns.”

Based on the 2006 emission figures of CLP’s Castle Peak power station and Hongkong Electric’s Lamma power station, the firms had already met the caps for last year, except for particulate pollutants.

Man Chi-sum, chief executive officer of Green Power, welcomed the link between emissions and returns but said the government should set out future caps clearly, especially those for after 2010.

“The precondition for its success is to gradually tighten the caps in the long term,” Dr Man said. “So it is time for us to consider the caps for beyond 2010.”

He said it would be difficult for the power companies to exceed the caps by 30 per cent. But Dr Man agreed that power companies might opt for the emission trading scheme with the mainland in case they faced a serious shortfall in the targets. He said the cost of buying credits from mainland power plants might be lower than the penalties imposed.

Apart from the penalties on exceeding emission caps, the new schemes will require the two power companies to carry out a combined 200 energy audits for clients and encourage them to adopt energy-saving measures.

They will also set up a loan fund totalling nearly HK$190 million for potential applicants to implement these measures.

If 18 million kWh could be cut, the two firms would get an extra 0.02 per cent in returns, which would equal HK$23.8 million.

But Mr Chu said the saving targets meant almost nothing as they accounted for only 0.0004 per cent of Hong Kong’s electricity consumption in 2006.

He said another scheme implemented since 2000 alone had achieved a reduction of 172 million kW.

Under the new schemes of control to begin in September, CLP Power and Hongkong Electric have accepted smaller profits. As a result, the consumer will pay a lower basic tariff. The firms also face a cut in their rate of return if they exceed any pollution emissions caps, but will be entitled to a slightly higher rate if they do not.

They will be allowed to make a 9.99 per cent profit on the value of their investment in fixed assets, compared with 13.5 to 15 per cent at present. Analysts calculate their average return over the past 10 years at 14.4 per cent. The new deal therefore represents a 30 per cent cut in core profit, a remarkable concession in Hong Kong. To make up for it, they will have to source more of their earnings offshore, a strategy they have already employed with success. ”

But they will not find a better rate of return. The reduced rate remains superior to the single-digit returns obtainable in the heavily regulated electricity markets of Australia, where they are both significant players, or of Britain. On balance, that is a good deal in a stable market where customers have a name for paying their bills.

And they have driven a tough bargain. The government has achieved its aim of reducing the rate of return to a single digit, but only by a face-saving 0.01 per cent. The 0.2 to 0.4-point cuts in the rate of return for exceeding any of the emissions caps are also derisory in terms of deterrent value. And there may be a devil in the details of the caps and cuts. A more effective incentive to cut emissions will be to avoid provoking critical scrutiny of their privileged market position.

The government says consumers, who will soon face power bill increases of up to 6 per cent, stand to benefit from cuts in the basic tariff that could reach double digits. However, the saving could easily be eroded by further increases in fuel costs, which are passed on.

That said, the new agreements are to be welcomed. The existing scheme served the city well because it encouraged investment in new generators and power networks to supply the demands of a growing population and industry. Now that population growth has slowed and industry has largely moved elsewhere, there is no longer any reason for virtual monopolies to be allowed to milk their customers according to that formula.

A higher rate of return – 11 per cent – on investment in renewable energy reflects the higher costs and the case for environmentally friendly measures. However, this is a reminder that over the decades the existing schemes were criticised for encouraging overinvestment in fixed assets. Officials should exercise discretion in the public interest in pre-approving new capital works, such as CLP’s plan to build a terminal for liquefied natural gas.

The agreements are for 10 years instead of the existing 15, as the government mulls models and regulatory frameworks for opening up the market to other players. The duopoly has made a pretty safe gesture in accepting it. If there is to be any competition, it is likely to be introduced in an orderly way. The government will be mindful of the imperative of stability in power supplies in an overwhelmingly high-rise working and living environment, and is unlikely to refuse to renew the agreements. Hong Kong has only two power suppliers, from generator to front door. They and the city need each other.

Hong Kong’s electricity duopoly are bracing for a 30 per cent cut in core earnings as early as October, but a lower return rate does not necessarily mean consumers’ bills will drop accordingly.

CLP Holdings (SEHK: 0002) and Hongkong Electric (SEHK: 0006) Holdings will have the return of their earnings on electricity supply slashed to 9.99 per cent from 13.5-15 per cent return on net fixed assets in use, forgoing HK$5 billion in profits between them based on their 2006 audited profits, the government says.

As part of the new regulatory regime on the power utilities, the new return means their core earnings will be cut by 30 per cent from the 14.4 per cent return the two firms have earned on average in the past 10 years.

The government trumpeted that the new regime accomplished its three main missions – slashing the utilities’ return to a single digit, lowering emissions and paving the way for an open market.

CLP and Hongkong Electric also accept that their contract period will be shortened to 10 years from 15. The conclusion of 18 months of negotiations means a U-turn of the power firms’ ferocious opposition. “The deal is as good as they can get compared to what they are earning in developed countries like Australia and the UK,” said an analyst of a European brokerage who expected future returns to be 10 per cent.

“A 10 per cent return is perceived as very attractive in these countries, and the two companies obviously know this very well because they invest there,” he said.

Many analysts believe the deal is reasonable for the two electricity companies and clears up regulatory uncertainty. But academics and analysts believe power bills will not necessarily be reduced at the same rate, as the new regime continues to peg the utilities’ core earnings to capital investment in power generation, transmission and distribution.

One pointed out that the prevailing higher cost of fuel could offset a cut in the basic tariff, as consumers must pay for the cost of production despite the government’s forecast of a “double-digit” reduction next year.

CLP, which serves Kowloon, the New Territories and Lantau, will embark on the new regime in October and Hongkong Electric, which lights up Hong Kong and Lamma islands, in January next year.

The government on Monday entered an agreement with the territory’s power companies – in the wake of community concern about utility fee rises scheduled for early 2008.

The two power companies are the China Light Power Company and Hong Kong Electricity Company.

The government said that under the new agreement, the rate of return of the two utility companies would be reduced to below 10 per cent to ease the public’s monthly electricity bills.

Secretary for the Environment Edward Yau Tang-wah said the new agreement would help allay community concerns gathered from two public consultations in 2005 and 2006. The new agreement would also be in line with the government’s environmental policies.

“I firmly believe that the new agreements have achieved a reasonable balance. On the one hand, we have responded to public aspirations for reduced tariffs.

On the other hand, the permitted rate of return under the new agreements will provide sufficient incentive for the power companies to continue investing in the electricity supply,” Mr Yau said.

Under the new agreement, the permitted rate of return of the two power companies would be reduced from the existing 13.5 per cent to 15 per cent to 9.99 per cent.

Customers of China Light Power Company and Hong Kong Electricity Company would see reductions in basic tariffs from October 1 this year, and January 1, next year, respectively.

However, the reductions would depend on the balance of the average net fixed assets of the two companies and their operating costs upon commencement of the new agreements.

“Based on the balance of the average net fixed assets of the two power companies for 2006, the total reduction in electricity payments for residential and commercial customers can amount to HK$5 billion annually,” Mr Yau explained.

Emission reductions are also an aim of the new agreements. If the power companies exceed the emission cap for any pollutants agreed upon, their rate of return would be cut by 0.2 to 0.4 percentage points depending on their actual emission levels. A maximum penalty of HK$200 million to HK$300 million would also be imposed.

Mr Yau said the government would also offer incentives. If emissions by the companies were kept below the stated caps, then an increase of 0.05 to 0.1 percentage points would be awarded.

“This also strikes a balance between the environmental obligations of the power companies towards our air quality as well as providing them with a stable operating environment,” he explained.

The environment minister said the government wanted to expand the electricity market to encourage friendly competition.

Studies on open market models and the regulatory frameworks, as well as enhanced interconnection between the grids of the two power companies, would be carried out in the next regulatory term.

“On the preparation for an open market, the tenure of the new agreements will be reduced from the existing 15 years to 10 years,” Mr Yau said.

Limits on the amount of pollution CLP Power’s gas-fired power station may emit have been renewed, but with the proviso that the company may breach them if it reduces pollution from its coal-fired turbines.

The Environmental Protection Department said the proviso was intended to encourage the company to use more gas.

“This offsetting arrangement will ensure a greater net reduction of the overall emissions from power generation, which is the biggest local source of air pollutants,” a spokeswoman for the department said.

However, CLP Power says it faces a shortage of gas supplies – the reason for its application to build a liquefied natural gas terminal on South Soko Island, in a marine reserve off Lantau, to receive overseas gas supplies shipped by tanker.

There are no figures for its output of pollutants last year, but it announced in December 2006 that the proportion of electricity it would generate in 2007 from gas would drop by a third to conserve supplies from its Yacheng gas field off Hainan , and that it would burn more coal, pushing up emissions.

The power station at Black Point, Tuen Mun, will be allowed to emit 520 tonnes of sulfur dioxide, 5,200 tonnes of nitrogen oxides and 65 tonnes of particulates per year this year and 2009. In 2006, the latest year for which figures are available, emissions of sulfur dioxide and nitrogen oxides came in far below the caps, at 180 tonnes and 1,962 tonnes respectively, but particulate emissions, at 70 tonnes, breached the cap.

The cap extension was announced as the deadline for agreement between the government and Hong Kong’s two electricity suppliers on new scheme-of-control agreements regulating profits on their investments passed without a deal.

“The talks have been very difficult. So far there is no comprehensive and concrete agreement,” a source close to the negotiations said. The source would not say whether the talks would be extended.

The government had said earlier that if the deadline passed without agreement, it intended to draft a law to regulate the companies.

Tso Kai-sum, managing director of the other power generator, Hongkong Electric, said three weeks ago that a deal was close.

CLP has a subsidiary in Australia which has set a standard to cap emissions, according to Yeung.

She also explained that the carbon intensity reduction did not amount to an actual cut in carbon emissions if the company continued to increase its energy production.

“They are playing with figures to give the public an impression that they are a green company,” she claimed, adding that power plants are Hong Kong’s largest greenhouse gas emitters, accounting for about 70 percent of total CO2 emissions in the city.

“The government only restricts power plants’ air pollutants at the moment but to combat climate change, it should also regulate their CO2 emissions.

“If power plants exceed the caps, they should be penalized financially,” she said.

CLP on Friday said a major initiative for Hong Kong is to bring in a liquefied natural gas terminal to increase natural gas in fuel mix of up to 50 percent for power generation against the current 30 percent.

Developing an offshore wind farm in Hong Kong is a possibility that the company will also look into.

CLP now operates one coal-fired power plant in Hong Kong at the Castle Peak power station.

The company said it is committed to not building new coal-fired power stations in Hong Kong or in developed countries.

It has plans for a transition from conventional coal to more climate-friendly fuels or technologies.

In developing countries where the company has conventional coal-fired generation plants, it will ensure they can be fitted with carbon capture and storage equipment to tackle emissions.

The CLP group (SEHK: 0002) set a voluntary target to cut its carbon emissions per unit of power output by 75 per cent by 2050, says Andrew Brandler, Chief Executive Officer of CLP on Friday.

“The plan is part of our pledge to fight global warming and reduce the effect of climate change. It is going to save millions of tonnes of carbon emissions between now and 2050,” Mr Brandler said.

As an interim measure, there will be a 5 per cent cut over the coming three years.

“We would achieve our target by increasing non-carbon emitting power generation capacity to 20 per cent of the total by 2020, through greater use of nuclear, hydro-power and renewable energy,” Mr Brandler explained.

He also revealed CLP would not build any more conventional coal-fired power stations in Hong Kong and other developed countries, to reduce the worse effect to the environment.

At the moment, CLP runs two major power stations in the New Territories – one in Castle Peak and the other one is in Black Point, both are in Tuen Mun.

Some Greenpeace activists hang a banner that reads “Climate change starts here” from a silo at CLP Power’s Castle Peak plant in Tuen Mun on Thursday while the UN Climate Change Conference was holding on the Indonesian island of Bali, urging the government to regulate its carbon dioxide emissions.

Greenpeace climbers captivate power plant urging government to regulate its CO2 emissions

Hong Kong SAR, China — While the UN Climate Conference in Bali is thrashing out solution to global warming, two Greenpeace vessels gear towards the Castle Peak Power Plant, allowing the climbers to scale to a 30M-tall ash silos and suspend a 15m x 15m banner reading “Climate Change Starts Here” to protest against the government shirking its responsibility to restrain greenhouse gas emission from power plants.

Four Greenpeace climbers captivated today the largest local perpetrator of climate change, CLP Castle Peak Power Plant, while the UN Climate Conference in Bali is thrashing out solutions to global warming. The climbers scaled the fly ash silos and dropped a massive banner to urge the government to limit carbon dioxide emissions from power plants as a move to tackle climate change.

Frances Yeung, Greenpeace Climate and Energy Campaigner, says the action alerts the public to indifference of the government to damages the power plants have done to the climate. “While other countries and metropolitans have already taken actions, Hong Kong government has made no immediate response to reduce greenhouse gas emissions from the power plants. Donald Tsang’s boast of his concern to global warming is far from the truth,” says she.

Power plants are the biggest local source of greenhouse gas emissions, which account for about 70% of carbon dioxide emissions (the major warming gases) in Hong Kong. Among them CLP is the biggest polluter, responsible for half of the release.

At present, the Government does not regulate emissions of carbon dioxide. Greenhouse gas emissions in Hong Kong have been increasing rapidly over the decade. Between 1990 and 2005, the emissions have increased 14%.

The government is now negotiating the new Scheme of Control Agreement (SOC) with the two local power companies which will last for 10 years. Greenpeace believes that global warming is too serious for the government to allow power plants to continue damaging the climate. The government must limit carbon dioxide emissions from power plants and their profits must be deducted if they exceed the emission caps.